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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day, and welcome to the Zillow Group Third Quarter 2019 Earnings Conference Call. Please note, this event is being recorded. I would now like to turn the conference over to Dawn Lyon, Chief Corporate Relations Officer and acting Head of Investor Relations. Please go ahead.
Thank you, Amy. Good afternoon, and welcome to Zillow Group's Third Quarter 2019 Conference Call. For those on the call I have not yet met, I look forward to doing so soon. Joining me today to discuss our Q3 results are Zillow Group's Co-Founder and CEO, Rich Barton; and CFO, Allen Parker. During the call, we'll make forward-looking statements about our future performance and operating plans based on current expectations and assumptions. These statements are subject to risks and uncertainties, and we encourage you to consider the risk factors described in our SEC filings for additional information. We undertake no obligation to update these statements as a result of new information or future events except as required by law. This call is being broadcast on the Internet and is accessible on our Investor Relations website. A recording of the call will be available later today. During the call, we will discuss GAAP and non-GAAP measures, including adjusted EBITDA, which we refer to as EBITDA. We encourage you to read our shareholder letter and earnings release, which can be found on our IR site. They contain important information about our GAAP and non-GAAP results including reconciliations of historical non-GAAP financial measures. In addition, please note we refer to our Internet, Media & Technology segment as IMT segment. We will open the call with brief remarks followed by live Q&A. I'll now turn the call over to Rich.
Thanks, Dawn. Hey, everyone. Thank you for joining us today. Our third quarter results were strong, demonstrating Zillow Group's business model expansion to mechanize real estate transactions is gaining traction as consumer demand reveals people want an easier way to buy, sell, rent and finance homes, what we call Zillow 2.0. Our vision is to create an integrated real estate experience that combines advanced technology with high touch services into a single platform to remove friction and one day, make moving between homes as simple as trading in your car. Today's on-demand consumers are ready for this new frontier in real estate and they want to work with Zillow, a brand they know and trust, and an app they already use and love. We are in the early stages of replatforming an industry with a $1.8 trillion TAM. We have a strong cash position, having recently raised $1.2 billion through our convertible debt offering. And just 2 weeks ago, we closed on an additional $500 million nonrecourse credit facility to support growth in our Zillow Offers business. Before I get into this quarter's highlights, I want to pause a moment and rewind. We received feedback that many of you would like more clarity on our Premier Agent business model, specifically as it relates to the impacts of our Flex tests. To clarify, the success measures for our Premier Agent business remain the same. Regardless of monetization model, we maximize for customer satisfaction, revenue and profit yield per lead. To recap, during our Q2 call, we announced plans to announce our Flex test into Phoenix and Atlanta in Q4. These plans affected our 2019 revenue and EBITDA outlook because we expect a portion of our prepaid lead generation revenue to shift to the future periods. In the Flex transaction model, we are paid a success fee only after an agent closes the deal. Because every real estate transaction is different and time lines can vary significantly from several weeks to several months, we are being methodical in our testing to better understand the financial implications of this postpaid pricing model. In total, our Flex tests, including Phoenix and Atlanta, are expected to represent only 5% of Premier Agent MRR as we exit 2019. We fundamentally believe Flex will be a win-win-win. It will offer better service for customers, better business for our partners and better profits for Zillow. However, we will not expand Flex beyond the current announced 5% of MRR footprint until we have the data to convince us and you that Flex will ultimately become accretive to our bottom line. Having just talked about the boundaries of Flex, I'll zoom up one click and talk about our Premier Agent business, which reaccelerated this quarter. Revenue exceeded our outlook, coming in at $241 million, an increase of 3% year-over-year. Excluding the impact of the 6 markets we are testing different iterations of Flex, Q3 Premier Agent revenue grew 5%, which you'll see reflected in the chart on Page 5 of the shareholder letter. This chart provides you with a same-store sales view of our MRR growth rates for our market-based pricing model, which reveals accelerating growth rates in this core business. We expect same-store sales growth to continue to accelerate in Q4, which has prompted us to raise Q4 and full year revenue outlook for Premier Agent. As a reminder, it's the size and strength of Premier Agent and other marketplaces in our IMT segment that allow us to invest in and expand Zillow Offers and other transaction businesses so quickly. The combination of these highly complementary businesses provides Zillow Group distinct competitive advantages. Said another way, the success of Premier Agent and IMT is fundamental to the success of Zillow 2.0. This was reinforced in our Q3 as increased operating leverage and agent retention levels contributed to expanding IMT EBITDA margins that we are able to reinvest in Zillow 2.0. The future of Premier Agent is dependent on strong and constructive partnerships with the best of the best agents and teams. Last week, our team hosted Zillow Unlock, our largest industry conference to date, in which we invited the top premier agents, rental property managers and homebuilders to Las Vegas to share our future vision. This included 1,500 of our top premier agents with whom we discussed the importance of working together as our co-pilots to help navigate and lead Zillow 2.0. We believe strong partnerships with top professionals who are supported by modern technology and offer highly personalized services are the key to unlocking the full potential of this evolving category. The positive reception and high engagement from our partners reinforces for me that we are onto something. It's not just consumers who are ready for Zillow 2.0. The industry is ready as well. Turning to Homes. The third quarter marks the first time Homes segment revenue exceeded our IMT revenue, coming in at $385 million, ahead of our outlook and up from just $11 million in the third quarter of 2018. During the quarter, we purchased nearly 2,300 homes and sold more than 1,200 homes. In just 18 months, Zillow Offers is live in 21 markets. We launched a record 8 markets in the quarter, one about every 2 weeks. Our Zillow Offers team has delivered ahead of schedule on a remarkable growth pace, and we are now getting close to a national footprint, which has been an early goal for us in order to drive national marketing efficiency. Our unit economics for Q3 came in within our targeted range, which, as we previously discussed, is plus or minus 200 basis points average return per home before interest expense. At scale, we are targeting 400 to 500 basis points, and we also see profit opportunity from adding adjacent services to the transaction. And speaking of adjacent services, Zillow's new homegrown closing service is also now live in a handful of markets. These are very early days and small numbers, but we are encouraged by the early consumer signals we're receiving that reinforce the value of bundling multiple services around each real estate transaction. To wrap on our Homes segment and Zillow Offers, I'd like to highlight that this kind of growth from a standing start may not be unique but it is certainly rare, and was our hope to not just get -- and it was our hope to not just get on the field in this big, exciting consumer category but to become the team to beat. And doing so within our profit rails is even more impressive. Few teams can pull off that kind of new business entry so quickly, and it took the whole of the Zillow Group team to make this happen. And I want to thank and applaud them. The company is now in a much more secure strategic position for the long term and has a much larger market opportunity as a result. Another essential piece of the integrated transaction is Mortgages, which delivered as expected in Q3. In the third quarter, we welcomed seasoned executives with deep experience building, scaling and running consumer direct lending businesses. Rian Furey joined as President of Zillow Home Loans. And Libby Cooper joined as VP of Operations. Combined, these 2 have more than 40 years of experience. We are thrilled to have them on board to build out our home financing platform. Recent positive feedback from our customers demonstrates the substantial value that Zillow 2.0 provides when we begin to offer and streamline all aspects of the transaction. Take Tim, a retired U.S. Marine who lived in Riverside, California and got a job offer in Phoenix. As he was checking his Zestimate on Zillow this summer in anticipation he might sell, he saw a button on his home details page that invited him to request an offer from Zillow Offers to purchase his home. He clicked. And in 48 hours, he received an offer that he believed was fair from a brand he trusts. He went through the process and after 6 days, accepted the offer and went on to start the process of finding a new home in Phoenix. He was referred to a Zillow Premier Agent who helped him find his new home at the same time he was preapproved for a loan through Zillow Home Loans. You will find a link to his video interview on Page 7 in our letter. Stories like Tim's are our inspiration and give us the opportunity to see the real potential of the business we're building. It's gratifying to watch our plan to help people unlock life's next chapter come together. We have a long way to go to fully realize our vision. But the possibilities of bundled real estate transaction experience through a one-stop Zillow platform that helps people save time, money and hassle are clear. Real estate broadly defined is a huge industry that has been impressively resistant to technological advance. The Internet, connected to a PC at first, and now billions of smart devices, has given power to the people and transformed industry after industry, many of which I have been lucky enough to have had a part in. Consumer expectation for speed, convenience and price is at a historical high and is accelerating at what seems at times a nauseating pace. Modernizing and replatforming this massive industry will take time and investment, but it is inevitable. And we have the brand, traffic, skills and the capital to lead this phase shift. This is why the Zillow team and I are here and so fired up. We balance our excitement with long, multicompany demonstrated experience building profitable businesses, the most obvious example being our IMT businesses right here inside of Zillow Group where we are showing profits and demonstrating leverage. Allen, the rest of the team and I treat the investment you have made in us with respect and care. We are meaningful shareholders as well. Thank you for your partnership. I'll now turn the call over to Allen to walk us through the results in greater detail.
Thank you, Rich. I'm going to quickly summarize a few key financial results. Overall, we exceeded our revenue and EBITDA expectations for all segments. In Q3, we reported revenue of $745 million. That's up 117% year-over-year and exceeded the high end of our outlook. Much of this growth in revenue was driven by our Homes segment, which generated revenue of nearly $385 million, growing 55% sequentially, and as Rich noted, is continuing to outperform expectations. IMT segment revenue grew 7% year-over-year to $335 million and exceeded our outlook. Premier Agent revenue exceeded our expectations at nearly $241 million, up 3% year-over-year. As Rich noted, we are pleased with the stabilization and recovery in the Premier Agent business. As we highlighted in our shareholder letter, growth in our core Premier Agent market-based pricing business on a same-store sales basis was up 5% in Q3. And we expect this year-over-year growth to accelerate in Q4. As we stabilize Premier Agent retention, we have been focused on managing costs and driving increased profitability, primarily in our IMT segment. To that end, I am pleased to report that for the 9 months ending September 30, we expanded IMT EBITDA margin by 240 basis points and grew IMT EBITDA by 19% year-over-year. As I've stated in previous earnings calls, during this time of transformation at Zillow Group, my priorities as CFO are focused on establishing processes and mechanisms in support of the following: scaling our new businesses; executing within our IMT segment in order to fund investments into new segments along with additional growth opportunities; and implementing focused cost discipline and operational rigor across the company as we scale. I am pleased with how we have executed on those 3 priorities through the first 3 quarters in 2019, and I will continue to be laser focused on them as we continue our business transformation. We ended the quarter with $2.3 billion of cash and short-term investments on our balance sheet, including the proceeds we raised in our recent $1.2 billion convertible debt offering. In addition to the cash and investments on our balance sheet, we are pleased to announce that in October, we completed our third nonrecourse asset-backed credit facility for our Zillow Offers business. This new facility has a maximum borrowing capacity of $500 million, which combined with our 2 other Zillow Offers facilities, brings our total nonrecourse asset-backed facility maximum borrowing capacity to $1.5 billion. As a reminder, these facilities provide us the ability to finance up to 85% of the home value using each home as collateral. We believe the amount of cash and investments on our balance sheet, combined with our asset-backed credit facilities, provides us significant flexibility to take advantage of market opportunities while prudently managing expenses, gaining operating leverage and being mindful of our weighted average cost of capital. Before we take your questions, I want to take a moment to provide some comments on our outlook. Due to the underlying strength of Premier Agent, we are updating our IMT and Premier Agent full year revenue guidance ranges. For IMT, we expect revenue growth of 6% at the midpoint, and we're bringing up Premier Agent full year outlook to between $915 million and $919 million, which represents 2% year-over-year growth at the midpoint. For Q4, we expect IMT revenue growth of 4% and Premier Agent revenue growth of 3% of the midpoint. We are also bringing up the full year outlook of IMT segment EBITDA to between $284 million and $289 million. The consumer demand for Zillow Offers service continues to be strong. We're anticipating Q4 Homes segment revenue to grow to $465 million to $490 million or 24% sequentially at the midpoint of the range, which reflects the sequential uplift from new market openings, partially offset by seasonal slowing in our home acquisition rate, consistent with seasonal market trends. This brings our full year revenue estimate for Homes to $1.23 billion to $1.25 billion. We are also tightening the range of full year Mortgages revenue to between $97 million and $100 million. On a consolidated basis, we expect full year revenue to be in the range of $2.59 billion to $2.62 billion, and we expect full year consolidated EBITDA to come in between a loss of $1 million to income of $17 million. In all, we are pleased with our Q3 performance and continued execution to streamline real estate transactions to better help our customers move easily. With that, operator, we'll open the line for questions.
[Operator Instructions] The first question comes from Brad Berning at Craig-Hallum.
Congrats on the inflection point in the Premier Agent revenues and the margins. And thank you for the same-store sales disclosure ex Flex. But wanted to follow up a little bit deeper on your commentary here. Can you talk a little bit more about what you're seeing as the drivers behind the improved activity and what trends you expect in the same-store sales basis that's included in the 4Q guidance? And how are you thinking about early reads and how that's going to develop as we go into 2020?
Okay. Thanks. Thanks, Brad. I'm looking at my watch right now and realizing that we read too fast, Allen. And so maybe we're in for a lot of questions. So let's take a deep breath. Yes, I mean the PA business is really healthy. As you noted, it's looking good. It's kind of a reacceleration of revenue. When we look at the same-store sales number that we're sharing right now, it's really comforting. Not to mention the kind of EBITDA, the business leverage we're seeing in the IMT segment overall, which happens to coincide with about the time Allen has been here at the company. But we're not only seeing revenue growth. We're seeing leverage on the cost items, too. So that's all good. I think the trends -- the inputs are what we try to focus on the most, Brad, the -- and these inputs are looking good. Customer satisfaction is up. Connection rate is up. Retention rate for PA customers is up. So the MBP, the market-based pricing model for PA is working really nicely. We -- as we look forward into Q4, we expect continued improvement in these inputs. And so that kind of is what's driving the Q4 guide. We're expecting to see more of that goodness. Relative to next year, what we look forward to, to giving 2020 guidance next quarter. We're just not -- we're not ready to talk about it yet. But we look forward to chatting with you about it then. I don't know if you have anything to add, Allen.
No, I think that's fair.
The next question is from Ron Josey at JMP Securities.
Maybe just a quick follow-up on that, Rich. Good to hear retention rate's up, marketplace pricing model was up. So I'm curious, when we did take down guidance in 2Q and now we're coming back to potentially where we were, was this all a surprise or just plans along the way? I guess you did it first question. You maybe sort of answered that with Brad but I just wanted to clarify. And then just on Flex really quickly. I appreciate the color and transparency, understanding no guidance into '20. But when you're thinking about how long it takes to prove out these test markets, and understood the 5% or what have you, just can you give us a little more insight in terms of like what you've learned thus far so that at least we can think about the opportunity as we move to potentially this type of this model going forward?
Okay. Ron, thanks. Maybe I think, Allen, take the first part.
Ron, I'll take your first part of the question.
Or maybe take a crack at the second one -- I'll take it.
So the guidance we provided in our Q2 call reflected the impact of us making the decision to expand Flex testing to Phoenix and Atlanta. When we look at Q3 performance and the guidance we're providing in this call, that change in guidance reflects improved Q3 performance that we saw in the business. Rich touched on some inputs. We also saw improvement in our sales productivity. We touched on agent retention better than expected. So we saw several of those inputs trend better than expected. And so our current Q4 and full year outlook for PA reflects the continuation of those trends. And again, I'd like to reiterate, Rich touched on it as well, what we're really excited about is while the input trends are working well, in our recurrent revenue business, when we come off of that recurrent revenue balance, we have to build it back up before we can start to see growth again. As we did that this year, we were also able to focus on cost discipline, productivity and thoughtful resource prioritization, all of which are areas that I've discussed are a priority of mine. And by building that muscle, we've been able to expand margins, which have allowed even with a 6% IMT growth rate in the first 9 months, we've seen 19% growth in EBITDA.
Great. And as to your Flex questions, I guess the headline is we are optimistic. We continue to be optimistic that this can be a win-win-win, that it really feels good from a customer satisfaction perspective to lash our compensation to the completion of what the customer is trying to get done, that is close the transaction. And that is clearly playing out. It also is a much more attractive model for a certain kind of partner. And we're getting a lot of positive feedback from the subset of our partners that are using Flex right now and other partners who are anxious to do that. And then we continue to be optimistic that we can derive more revenue and more profit from the same lead flow through this model. This is all being tested, however. The time horizon for figuring out exactly how this is going to play out is a little bit -- is painfully long, I understand. It will take some time. For instance, we've announced 6 markets that we're testing Flex in. And again, those 6 markets represent only 5% of our MRR. One of those markets, Atlanta, we haven't even launched yet. We'll launch in next month -- next week.
Next week.
Next week, okay. So we launch Atlanta next week. And in Atlanta, we won't have -- it's not like we'll have all the data. Even the front-end, even kind of the starting gun of the transaction, it won't all happen at once. It will play out over time. And it takes transactions from several weeks at the very short end to several months at the long end. And we need enough data -- we need to collect enough data to kind of prove out our theory. I do -- as I said on the call, this is a -- we continually innovate on business model in Premier Agent. And this is a really interesting innovation that we are testing. And finally, I guess I'd say while we are doing this, while we are innovating in these Flex test markets, our core business, the core MBP business is sound and reaccelerating and growing. And so that's pretty excellent, too.
The next question is from Mark Mahaney of RBC Capital Markets.
This is Mike Chen on for Mark. Just on Zillow Offers, you expanded to 8 new markets this quarter. I think that's the most you've ever done. I was wondering if you could talk a little bit about the pace of your market expansion going into and throughout 2020. And then you also saw nicely improved Homes EBITDA margin year-over-year and sequentially. But how should we think about the path to profitability and for losses to improve in an absolute basis for that business segment?
Okay. Mike, I'll take a crack. And Allen, pile on especially for the second half, if you want. I said it in my scripted part, but it's pretty remarkable how quickly this business, the Zillow Offers business, has grown. Of course, it is being driven by a really strong consumer signal with frustrated homeowners who want to move, saying they want a better way, okay? But growing from $11 million in revenue in this line item last year to $385 million this quarter is pretty fantastic. Getting to national footprint was one of our early goals, getting to effectively national footprint. And we're pretty close. I think we are at -- I think I said we are at 21 markets right now. We're about to launch the greater Los Angeles area next month. So it will be 22. I think historically, we've said and reinforced it, by mid next year, we'll be in 26 markets. But kind of Phase 1 of rapid scaling of Zillow Offers has been about planting flags in many markets and going broad, getting the word out, getting data for the machine -- learning machine input so that we can make better and better offers. Phase 1 has been about going broad. And we're moving into a Phase 2, which is getting some depth in these markets and figuring out how to roll out software and systems and processes such that we can gain leverage on the cost -- on the unit economic cost line items. And because the goal long term in this business is not to lose money on Zillow Offers and just make money on all the adjacent products, we are aiming to have the core Zillow Offers business make money in it of itself and make -- and do very well and then also give us all kinds of fantastic optionality on these myriad of verticals that surround the house transaction. I don't know if I covered the whole question. Homes, EBITDA, I mean I kind of hit some of it.
Yes, yes. And I would just add to Rich's point. It is pretty incredible, the performance we've gotten at the pace of scale. We've continued to execute within our target ranges on profitability for home, which we share.
Which is kind of a surprise, honestly.
Yes. And so as we think to the future, I still come back to the customer signal that we're getting is extremely strong, which gives us a lot of excitement. But we also plan to be prudent and make sure we understand where there's opportunities to make investment and where we need to test a little more before we go big. And so I think we're in a really good place. I think we're best positioned to win. I've been really excited in this last -- it's only been 9 months, almost a year, I guess, watching this team go after this. And I think we're in a good place going forward.
The next question is from Tom Champion at Cowen.
Allen, you've talked about Zillow's progress in building skills around cost control. And it was a very encouraging result in EBITDA in IMT. And I'm just curious if you could talk through that, if there were any cost items that helped the result, anything onetime in nature. And then maybe a question for Rich. I'm just curious if you could qualitatively describe what you're seeing in the older offers market. And in particular, curious the feedback you're getting from agents tasked with introducing a Zillow Offer to customers that maybe those customers ultimately choose a standard market transaction. Just any thoughts on that would be really helpful.
Yes, yes. So Tom, the savings or the productivity and margin expansion that we're seeing are coming from a wide range of places with respect to IMT. What I'd say is we're establishing just a little more rigor around how we measure, how we think about incremental investments, how we measure productivity and how we ensure that we're kind of maximizing every dollar spent to get the maximized return. And that is paying some yields. The specific areas of leverage that you see year-over-year in that 9 months are around better leverage on some of our sales and marketing dollars. We've seen better leverage on some of our head count. And that head count includes people cost. That includes a lot of discretionary spend that we are constantly looking at, T&E and other spend that we're looking at and finding real savings year-over-year through 3 key levers. We are either negotiating more aggressively with vendors. We are clarifying and basically holding to compliance against our policies. And we're looking at demand management. It's those 3 simple levers across a variety of spend categories that we put in place and we have discussions about that are starting to yield some improvements. We expect that to continue, and that can either fund investments or can drop to the bottom line. But we're excited about the progress.
Tom, as to your second part of your question, there aren't any older Zillow Offers markets. Really, our oldest markets are, I don't know, 15 months old. So they're quite -- so they're still quite young. And trying to draw any kind of maturity conclusions from them, it's just -- it is just premature. I'm very happy with the way we're executing in these markets within the guardrails we've laid out. And the amount of data coming in from these markets and the amount of learning that's happening is really -- it's impressive and rapid. As to taking advantage of the kind of adjacent lead opportunities and adjacent vertical market opportunities as a result of being able to present all these offers to people and then actually having these listings, the currency of the realm in the real estate industry is listings. And we have all these listings now. We have -- how many homes do we have listings on right now? Over -- we have 2,800 homes in inventory right now, 2,822 homes in inventory. Not all of those are in the market yet but a good chunk of them are. And the commission lead opportunities that kind of -- all the lead opportunities that come from having these golden listings is also pretty impressive. I would say it's very early days with us monetizing all of that. We've had more success with -- early success with some things than others. We've talked a little bit about Zillow Closing Services, which includes title that we are just beginning to test with. That's small. We're also testing with Zillow Home Loans. It's just begun to actually be integrated in certain test markets so that we can see what the attach rates are. We're also playing around with seller and buyer leads that can result from these offer presentations, and that's -- we're figuring that out. We remain, long term, very confident and optimistic that there is a ton of opportunity in these adjacencies.
The next question is from Lloyd Walmsley at Deutsche Bank.
This is Greg on for Lloyd. One, on the Premier Agent business. So you talked about retention improving. But can you maybe shed some light on the demographic agent who isn't necessarily coming back? So maybe the spend type or geographically. And then two, on Homes. With the recent developments in the private funding market, have you seen the competitive environment change at all such that the iBuyer path to profitability may be better than you initially thought?
Greg, so I guess I would say with kind of broad strokes, we have all kinds of Premier Agents that are seeing success with our model. And depending on the size of the city and the kind of city and the kinds of homes in the city, these can -- it can differ. But if I were to use a -- paint a broad brush and list some characteristics of agents where it's particularly well suited, I guess I would say that agent teams that are focused on a more mass market, mechanized, personal transaction with a team full of people that may have some specialists so they can handle the kind of mechanization it takes to analyze a business with a bunch of incoming leads, and then either monetizing that via the MBP model or in the 6 Flex markets, figuring how to nurture that lead all the way to the transaction using their tools and increasingly our tools to nurture that lead along the way. These more mechanized business like teams are the ones that we think are, at least, demonstrating best fitness for what's coming -- what we think is coming in the future. I guess that's what I'd say generally. I forget the Homes question.
Private funding market, have you seen the competitive landscape kind of develop any differently?
Right. Feels different. Feels a little different. I don't want to get too over -- too optimistic too early. It has been a burr under my saddle, the easy money, easy late-stage money. Because you got to play the game that's on the field. The game on the field feels like it's changing a bit. And the easy money might not be so easy and may be a bit more demanding. I am extremely glad that we have this incredibly healthy core business in our IMT businesses that is growing nicely, gaining leverage, generating all this EBITDA for us to use to invest in kind of the next generation of growth and TAM. I'm also really happy that we decided to put $1 billion or so on the balance sheet this past quarter in the convertible offering that we did while we could. That, we feel like, we are in a really strong balance sheet position to fund our growth plan, which is -- it's a real and exciting growth plan, but it's one that we are approaching with Allen by my side, put it that way, not just me but Allen is here. And so I would say overall, I read the news and I'm listening to stuff that's coming out of Masa's mouth at his press conference yesterday and we're listening to things. I'm getting happier about the competitive environment, but I think it's too early to say we're in a normal funding environment.
The next question is from Maria Ripps at Canaccord.
Maybe just to follow up on the profitability question. So without providing any specific guidance, can you maybe share with us your thinking around improving profitability versus investing for growth next year? And what are key investment priorities for you in 2020 outside of the Homes segment?
I don't know if I can punt that piece, the first part to you. I mean we're not giving guidance yet, but...
Yes. I mean I would say that in terms of what do we think our investment priority or how we will invest next year, I think that we continue to expect to scale Homes. And as we talked about, we are going to test our Flex business model while continuing to focus on our agents and customers using the MBP model, and we'll continue to put the tech and the stack in place with our 2 new executives on the Mortgages to grow that business. So I mean that -- I'd look to our long-term targets to provide you the best guidance on kind of how we'll be thinking about our investment cycle over the next few years. I look forward to sharing more detailed 2020 guidance next year. But as I mentioned on my focus, I will continue to focus on areas where we see the ability to improve productivity, do better resource allocation or build that muscle around disciplined spending that just allows us the flexibility to invest in Zillow 2.0 or to let that go down as margin expansion. But we're not providing any guidance past our -- the guidance that we provided today in 2019.
The next question is -- are you ready for the next question?
Yes, please, Amy.
Okay. We have Heath Terry at Goldman Sachs.
Rich, just curious, obviously realized that everything about Homes and Offers is still really, really early. But if you could kind of mark-to-market for us some of the early assumptions that you and the team, obviously going back to Spencer talked about in terms of what was underlying some of the economics that Zillow was thinking about when it entered the business, the 90-day turns on home sales, the cost of caring, the cost of financing, sort of how have those assumptions evolved in the 15 months that you've sort of been in the business? Where do those numbers sort of sit in your model now that you've had a little bit more real-world experience in the business?
I mean Dawn is sitting next to me. And she hates it when I say I'm surprised that we're operating within the rails we laid out even 15 months ago, Heath. But we are. And I credit Eric and Jeremy and the Zillow Offers team. We have Eric Power in particular and his really talented team. Eric's in Phoenix. They came from one of the precursor companies, Invitation Homes. And they had built up, I guess, Invitation Homes. You guys would probably know better. It probably has 85,000, 90,000 homes that they own. Now that's a different business. But these folks had built up that business and really understood the line item -- many of the line items of economics that constitute this Zillow Offers business. And it's played out within our expectations, which I'm really pleased about, and done so while it's grown a kind of nonmeasurable percentage year-over-year, right? It's gotten -- it's growing really fast and gotten really big. It's -- I wish we had more evidence to point to you of line item leverage right now. We will in the future. But as I've said, I think on a previous question or maybe in the script, we -- step 1 was go broad. Step 2 was go deep and get leverage. I guess we can point to one point of leverage on the financing side. Of course, financing is a very important cost component in this business. And our -- I'm also really pleased with the way we have Eric Power and his team in conjunction with Allen have put together this layer of bilaterals, this kind of stack of bilaterals we've got in place, each one getting better. And one of the things that can come out of the financials from today, I think, has to do with our loan-to-value ratio.
Yes. I usually express a simple loan-to-value our -- I'll call it a leverage ratio, which is our Homes inventory value on the balance sheet at 9/30 versus the vehicles, the asset-backed credit facilities utilized. And that's 79% versus 74% at the end of 6/30. So an improvement of 500 basis points. That is reflective of our continued improvement on trying to ensure as we buy these homes and put them through these facilities, that we do it in a very effective and efficient way to ensure, where possible, we're leveraging these facilities for some of the capital needs we have versus our own capital. But I will also express that, that number will likely vary. We're still very early days, and that number will likely vary. But with respect to our asset-backed borrowing in the Homes business, we continue to work -- we announced a new facility today. We continue to work with a lot of different parties who are very receptive. And the goal we've expressed is that we want to go deeper, cheaper and longer maturity, longer, which provides us more flexibility. I would say the one, I'll call it, mark-to-market, as you called it, I think it's important to clarify is the 90-day hold time is one that's just hard because that's an average that really is representative of a lot of different distributions and not really representative of any of them. So when we buy homes, depending on price, market and a variety of other things, we expect those hold times to vary. That is reflective in our fee. I don't want to give the impression in all cases we are looking to reduce the hold times. But that 90-day across an average portfolio is just not the way we manage the business. We manage it across an expectation that we pay for. And again, we expect over time to improve that through a variety of ways.
We get paid for it.
Yes.
Let me wrap this one, Heath, by saying we really do think scale -- and I think I said this already, but we really do think scale in ZO matters. We think that we know that sellers are -- this is a pretty price-elastic business. And that every little bit that we are able to -- every little bit more we're able to offer a homeowner for their house because we're running a more efficient operation, we have cheaper financing expenses, we are able to sell a market these homes cheaper than onesie-twosie or small folks. Every little bit that we are able to do actually dramatically increases the size of the business that we think we can ultimately run. So these -- there is a, I guess -- I don't know if I'd call this a network effect. It's not really that. It's just a scale effect. There's a strong scale effect, we believe, in the Zillow Offers business. So we think this is an important strategic decision to actually have this be big to make it get big.
Our next question is from Brent Thill at Jefferies.
This is Alex Giaimo on for Brent. Just going back to your comments around the iBuying competitive environment. I think we're starting to see some more overlap now between some of the bigger players. We heard from Redfin last night that they're ramping at a quicker pace as well. Just curious if that's starting to impact pricing at all and whether it impacts your thoughts around the pace in which you're entering new markets?
They are different, Alex. There are different things. There are different competitive dynamics and different kinds of tests and learnings going on in each market right now that we're in. And it depends on competition. It depends on a lot of different factors. And I guess I would use that as a way of saying that if you're scraping MLS data and coming to conclusions about what's going on in any individual market, don't over-extrapolate too much because it's early days and there are bunches. There are lots of tests going on. The amount of iBuying in totality is tiny. It's really tiny. Most people don't know about it, okay? It's really, really small. And so I don't -- we are not -- we have not entered a phase in this iBuying thing where the competitive dynamics actually matter all that much. They certainly come into play a bit. But the most important thing is for us to offer a product and a service at a price that is attractive to the old way of doing it. And that's what we are focused on right now.
The next question comes from Justin Patterson at Raymond James.
On PA, you talked about customer satisfaction and revenue and profit yield as the central pillars. Focusing on that, what are the key things to solve that bring a product like seller listings to market? And then secondly, a big picture one. Rich, you talked a lot about the vision of an integrated product. You've got a ton of areas where you can test and learn from PA, Mortgages and Homes. Since you've come back to the company, what are the biggest changes you've made to align the teams to execute on those areas without getting too far over their skis?
Okay. Good stuff. On the seller listings product, and I've chatted about it a little bit before, I do think of seller listings as one of many kind of knock-on or adjacent opportunities that are out there. And I guess I'd also say that while the revenue numbers are quite large for the Homes business, at the end, the number of units is still pretty small. And so the magnitude of the number of looks we're getting for this kind of opportunity are still really small and tiny compared to the hurricane of leads we get from our traditional business, the 2 billion visits a month that we get on our apps and sites. So it's early days there. We are rapidly learning. We are trying a whole bunch of different things. Some of you have sniffed around in markets and discovered all kinds of tests that we're running. And so we are trying things. Some things are showing promise. Some things are not working. From the second part of your question, it was the integrated product and what we are learning. And yes, so bringing on people who know how to run these businesses is job #1. We didn't have people that knew how to build the -- that knew how to buy this many homes. And we recruited an amazing team to do that. We didn't know about title and escrow, and we've recruited a fantastic team to do that. We didn't know how to create a mortgage. And so we purchased a small company last year and now brought on some really seasoned leadership from direct-to-consumer lending businesses to run the mortgage business. We are investing in these in a way that I would call aggressive but prudent without getting out over our skis, utilizing EBITDA from the main -- from our core advertising businesses. I feel really good that it's in balance and that it's working pretty well.
The next question is from Brian Nowak at Morgan Stanley.
So I have two. The first one just on the same-store sale acceleration in Premier Agent. I was wondering, could you just talk to sort of anything that changed from a consumer behavior perspective that drove this? Are you actually seeing more homes being sold to the platform that's driving more bidding around impressions? Like what's -- are there other changes made? What sort of drove the acceleration sort of mechanically for us as we sort of think about further levers to go? And then on Flex. Maybe walk us through sort of the framework that you guys plan to apply on a market-by-market basis as you're sort of evaluating which markets may or may not be best served with a Flex offering in them over time?
You want me to take the first?
Sure, sure.
Okay. So I kind of -- we've been talking about this recurrent revenue, MBP's recurrent revenue model that we have a really high churn. We dug ourselves into a hole. We've had to build ourselves up. So I do want to be clear that there was not a significant inflection point so much as the inputs have been going really well. And we saw what I'll say productivity and agent retention in Q3 come in better than we expected. So the 5% was better than we had expected, which is why we showed the results we did, and we expect this to continue in Q4. But a lot of these trends have been going on all year. We've had to build -- kind of dig ourselves out of this hole that we had dug when we had the high churn in the second half of last year. But -- and I think it's just basic blocking and tackling. PA Forward is providing more connections, more warm leads to our agents, which is getting customer and agent together. CSat is improving. We can't track conversion on all submits that we do, but we have indicators that conversion is improving. And so it's really just basic blocking and tackling. We've seen the inputs get better over time, and we just kind of had a little bit better productivity and retention that caused us to inflect a little better than our forecast, which we reflected obviously in Q3 results as well as our Q4 guidance. So it's just a lot of inputs that are slowly getting better, and we feel like we've got continued room to improve those.
I guess virtually, the market is -- the partners and our customers, the end consumers are responding well with this push that we're making to move down funnel in the core PA business as well, meaning we're taking care to make the connection, to make sure the meeting happens, to arrange the tour in a way that the tour actually happens and then to follow that shared consumer on their journey towards the transaction. We are building -- we continue to roll out tools that make that happen, and that's making the business work better. And we expect that to continue. The second part of your question was about Flex framework for evaluation. We're trying a diversity of things in these different markets. We hope that these 5, soon 6 markets, represent enough footprint and enough diversity for us to get a good test signal. Yes, to get a good test signal. So we're trying a whole bunch of things. We don't have any patterns to report on yet. Some -- in some places, some things are working. In other places, they are not. And so we are highly motivated because we're so optimistic that this is a potential big win-win-win all the way around, as you've heard us say. And we like it because it's better for customers, it's better for partners and it could be better for us. And it fits with this move down the funnel towards the transaction that we think is so key to unlocking all of these knock-on adjacent opportunities. Again, it will take time.
I think we said it, Rich. But we did choose Phoenix and Atlanta because they were ZO markets that we were...
The latest 2 markets that we've announced. I guess we announced it last quarter. But we're in Phoenix now. We're about to ship Atlanta. There's no surprise that those are 2 of our older -- I just said we do not have any old, 2 of our first Zillow Offers markets. And we have terrific ZO partners in those markets who we have done some of the most deep systems integrations with in order to follow these customers throughout the whole transaction. And we're leveraging a lot of that infrastructure to do these Flex tests as well. And so that's -- it's -- we're optimistic.
The next question comes from Brad Erickson at Needham & Company.
First, just I guess last quarter, felt like the message with Flex was definitely the future for the PA business. You're obviously talking about the merits of the better model, better monetization, better customer experience, all that. So I guess wondering why all of a sudden it seems like the message today is that legacy MRR is a little bit better and it's going to be more wait-and-see on Flex. I guess how should we take that in the context of which business model you're likely to pursue here going forward? And I guess secondly, is there a chance where if the economics on Flex aren't as good for whatever reason, would sticking with the MRR model work with the broader down funnel pieces here longer term?
There hasn't been any underlying change, Brad. There's just been a change in the way we communicated it and in recognition that we left a big open question unanswered last quarter in terms of, hey, it's just -- it is different -- it could be different revenue recognition, but it's just a test and we don't know when, et cetera. We just left a big question mark, which was a mistake. We're trying to solve for that this quarter, which is what you're detecting as a change -- as a potential change in the underlying way we're thinking about it. We're not. We are just changing -- we're saying look, this test, we're trying to frame it for you, saying it represents 5% of ARR -- excuse me, MRR in the business, which seems like a reasonable amount of MRR to test with, okay? And we're also going further saying, look, we need the data case ourselves and we know we need to make the data case to you to the extent we move beyond it. And while we are doing this, we're growing the core MBP business really nicely, getting leverage on that. We like that business, but we do think it can be improved. But we really like that business. Partners like that business and customers like that business, too. So...
The next question is from Andy Hargreaves at KeyBanc.
I'm just going to keep on the Flex themes, if that's okay.
No.
Do you want me to change? I can.
Just kidding, Andy.
What do you -- I'm wondering what you're looking for from a metric standpoint from demand, agent demand around Flex and if you guys can share anything around sign-ups or feedbacks so far, recognizing that it's still a test.
Yes. It's -- we just did this Unlock event in Las Vegas. I think we had 2,000 people overall. Maybe 1,500 of them were Premier Agents. These are the top agents and teams that paid to come. So it's not a representative sample of the total partner base we have. It's the most productive, the most forward-thinking. I would characterize it as -- these people are making their money from the business as it is -- as it currently is. And any change is a little scary. But I would say a large subset and growing are realizing this is a real potential game-changer for the business long term, for the whole industry long term. They are understanding that for the middle of the bell curve of real estate transactions, these are going to go to high-volume teams. It's going to get mechanized just like every other business that technology touches. And they are really anxious to be at the front of the queue for testing. A lot of hands are going up saying, when you come to [ export to ] my town, I want to be your test partner. And so that's an encouraging signal. There are others as well that we talk to and you might talk to as well that are -- think it's the end of the world is a little too strong, but are worried about it. They're making money the way they're making money and they don't want to change. But we want the best partners no matter how we monetize, okay? That's best for all and that's best for customers as well.
The next question is from Jason Helfstein at Oppenheimer.
This is Jason Hoffman on for Jason Helfstein. We were wondering how many -- like what is the percent of homes in inventory that is greater than 60 days? And just last quarter, you mentioned that you are increasing the size of your Flex test and now you're not. How much of that is being pulled forward into your guidance going forward?
Maybe we'll take the second question first just because I think it's shorter. I'm not sure I understood. We announced we were expanding our Flex test at the end of our Q2 call and that because we were going to be flipping those markets from our prepaid model to this Flex testing, which is where we get paid upon the close of the house that, that would have the impact of deferring revenue into future periods. And our change in guidance for the second half of the year was lowered to reflect that movement of revenue into future periods. Nothing has changed with respect to that. We are flipping those markets as expected. And so as I mentioned before, that impact in Q2 was driven by Flex, expanding that market. The adjustment -- the performance in Q3 and the adjustment to our Q4 outlook is reflective of our core MBP business improving in both sales productivity and retention rate versus our expectations at the time of the Q2 guidance. With respect to your first question, we don't provide a distribution of our homes and our aging. As I mentioned, we don't believe the actual age days is very reflective externally just given that it varies a lot by market, by price of home and a variety of other factors. All of our underwriting and pricing takes into -- takes that into account when we give -- provide our offer because homes that we believe will take longer to sell, we charge more for related to the holding cost, interest and others. So I think the best thing to kind of consider is we provide a per unit home metric, and then we did -- we talked about it last call, and we do assess as required to mark down our inventory to the lower of cost or net realizable value. And we do that assessment for inventory in the balance sheet on a quarterly basis. That's an accounting adjustment and does requires us to mark those -- that inventory that is below cost to a net realizable value. But it doesn't -- it's not a mark to market. So we don't take the mark on the high end. And that mark in Q3 was consistent with Q2 at a little less than 1% of the inventory value. So hopefully that helps.
The next question is from Naved Khan at SunTrust.
Just on that inventory evaluation, are there things that you tweak to your guidance, maybe in terms of just pricing and when you make the offers, you just hone that guidance as pricing is better and you do less of the adjustments? And then secondarily, on the integrated mortgage and origination offering. I guess on the last call, you said it was delayed. Any updates on when you can go to market with that?
Did you get the first part?
Can you just repeat the question on the -- you were saying are there things we could do, you were saying, that would reduce the inventory reserves?
The question ties to, I guess, the write-down on the inventory you carry. It's happened last quarter, and I think you said that it was similar adjustments this time around in terms of percentage of the -- as a percentage component. Are there things that you can do in terms of how you value the homes when you buy them so that you kind of lower the adjustment if it's further downward?
Yes. I guess what I'd say is in general, as we think about this business and we make offers to our customers who are interested in selling to us, we are attempting to provide them a fair value for their price adjusted for renovations that we need to make and what we expect the holding costs of that home over the period we expect to sell it along with a fee for the service we provide. So what I have learned in the Homes business is that obviously, pricing that home is very important. And that is where over time, as we get more data and we have access to a lot of data, we continue to get more. We will get better and better about what types of homes, what attributes to allow us to predict better what performance of that house should be within a range that we expect some to do better and some to do worse. But the smarter we get and the more we leverage data and machine learning, we will be able to tighten that standard deviation between what the average of that portfolio does. What this lower of cost or net realizable value reserve adjustment does, it's an accounting adjustment that requires to take those houses that are on one side of that standard deviation, i.e., that we are going to sell them for less than we bought them for, including selling cost, and make that adjustment in the current period versus when we sell it. We don't get a full mark where we take the benefit of the houses on the other side of the mean 1 standard deviation that we make more money. But again, as we -- what I guess I would say is our expectation or obviously the success of this business, data has to help us reduce that variance on a portfolio basis from the mean, when you think about 1 standard deviate -- that tail. And as we do that, we would expect to have less as a percentage in here, but it's a normal adjustment. And we do expect that there will always be homes on both sides, if that helps.
I don't know if we want to close on this with the sparkler. I can get this. You got that?
Yes. This is just to give people scale on kind of the homes economics. This would be basically accumulation of the per unit economics that we provided in the last 3 quarters. And it is lifetime or 4 quarters. Lifetime at Zillow, we sold 814 million homes -- we had $814 million of revenue off of 2,588 homes. Our return on homes sold before interest expense is $2.3 million, and that return on homes sold after it's expensed is a loss of $9 million. So in the scheme of -- when Rich talks about really excited about the scale we've had and how we're operating in the limits, that's a pretty tight -- that could have gone a lot of different ways.
It's impressive. It's impressive and relatively small. So it's a good way to -- and Naved, your last question was about the integration of mortgage. We're executing on our plan. It looks good. We've got some exciting new management in place with Rian and Libby that I talked about before. We are doing some localized test of integrated Zillow Home Loans. As per that fantastic video that I'm sure you guys a lot of times have clicked on from the shareholder letter, I -- it's a fun video actually and it's a true story. So it's cool. So it's beginning to happen. This one, like many of these adjacencies, is going to play out over time as we learn and build the business though. But we're excited about it. We're very excited about the long-term profit potential in these adjacent businesses. I think that's it. Thank you guys very much. We're really excited about the progress we're making to mechanize this transaction. And it's fun to update you guys on our progress along the way. So thank you for joining us on this. Thank you for your investment dollars. We will -- we take it -- as I said before, we care, we're shareholders and we will take care of your capital and do our best with it. Thank you for being great partners. Talk to you next quarter.
Thank you.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.